As the economy begins a gradual recovery from the pandemic, States will have to look at ways to improve their finances in order to direct expenditure towards more productive purposes. But to achieve that, they will have to prune their borrowings, which is leading to a high interest burden, crowding out other productive expenditure. An analysis by this newspaper of the debt of the top 15 States in terms of GSDP reveals that most States have significantly increased market borrowings in FY21 and FY22 to meet the additional pandemic related expenditure even as revenue receipts took a hit in the first year of the pandemic. These borrowings have taken the debt of some States to unsustainably high levels. While the Fiscal Responsibility and Budget Management (FRBM) Act lays down the ceiling for debt to GSDP ratio for States at 25 per cent, eight of the 15 States exceeded the limit in FY22 with States such as Punjab, Rajasthan and Bihar far above the mandated level. While the FRBM committee had recommended that combined debt of States should reduce to 20 per cent of GDP by 2023, State debt is set to exceed 33.5 per cent of GDP by the end of FY23, according to SBI Research. Unsustainably high debt levels, especially in States with relatively weaker revenue streams, can lead them towards a debt trap, where most of the revenue is used up to service the debt.

Interest cost for seven of the top 15 States has increased more than 40 per cent between FY19 and FY22. With revenue not keeping pace, the capacity of States to service rising interest costs is declining sharply, as indicated by reducing interest cover. Along with interest cost, many States have witnessed increases in other committed expenditure such as salaries and pension too, with the result that committed expenditure of States as proportion of revenue receipts is budgeted to increase to 56 per cent in FY23. With a large part of States’ expenditure already accounted for, there is little room for developmental expenditure that can help in long-term growth of the State. It comes as no surprise that despite the Centre’s nudges and incentives, many of the larger States including Maharashtra, Tamil Nadu and Karnataka have recorded a decrease in capital expenditure in the revised estimate for FY22 when compared with the budget estimate. With the States having to bear a large part of capex burden, this reduction in capital investment could have ramification on overall growth in the economy.

States need to be nudged back to the path of fiscal prudence soon, else their borrowings can spin out of control, with deleterious effect on growth. The FRBM committee needs to set out a glide path for States to bring their deficits and borrowings back to prudent levels, as soon as possible. With tax revenue showing buoyancy in recent months, due to revival in economic activity, States can repair their finances if they are careful with their expenditure. They need to introspect on the efficacy of freebies and subsidies which drain the exchequer without contributing to development. Some of the heavily debt laden States such as Punjab, Rajasthan and Bihar also top the list of States with a high proportion of average subsidy as per cent of GSDP. Of concern is the fact that governments in many of these States are continuing to announce populist schemes, unmindful of their finances.

Related Topics